View
220
Download
0
Category
Preview:
Citation preview
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 1/52
Name: Priyanshi Gupta Enrollment Id: 10BSPHH010572
Mobile No.: +91-9912633488 Email Id: priyanshi.gupta@gmail.com
Name: Pratik Tibrewala Enrollment Id: 10BSPHH010548
Mobile No.: +91-81431774470 Email Id: pratiktibrewala@gmail.com
SIP Report
Summer Internship Program
At
Edelweiss Financial Advisors
On
Analyzing VIX (Volatility Index) of Nifty
and forming trading strategies using
INDIA VIX.
Submitted To :-Submitted By:-Vishwanathan Iyer Pratik TibrewalaAsstt. Prof. (Finance&Accounting)10BSPHH010548IBS Hyderabad
ICFAI BUSINESS SCHOOL, HYDERABADDate of Submission: May 20, 2011
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 2/52
AUTHORISATION
The project report titled as “Analyzing VIX (Volatility Index) of Nifty and forming trading
strategies using INDIA VIX.” has been authorized by Edelweiss Financial Advisors as a part
of the evaluation for Summer Internship Program.
The project has been submitted as a partial fulfillment of the requirement of Masters of Business
Administration (MBA) Program of IBS, Hyderabad.
Submitted By: Submitted To:
Pratik Tibrewala Vishwanathan Iyer
(10BSPHH010548) Asstt. Prof. (Finance&Accounting)
IBS Hyderabad
Mr. Anil Thakur
R EGIONAL HEAD MANAGER
Edelweiss Financial Advisors
2
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 3/52
ACKNOWLEDGEMENT
Summer Internship Program (SIP) aims to provide every student with an opportunity to apply
theoretical concepts to the real business scenarios. The wealth of knowledge and experiences
shared by all involved in completion of successful internship is invaluable.
I feel privileged to be associated with Edelweiss Financial Advisors. I would like to put on
record my deep sense of gratitude towards the organization for providing me with this unique
learning experience and the requisite infrastructure.
This report has been made possible because of the support and guidance of many people. I am
grateful to Mr. Anil Thakur (Regional Head Manager), I express sincere gratitude to my
company guide and mentor for his encouragement, support and valuable guidance throughout
the project duration. The project was quite unknown to me and required lot of knowledge andguidance. In spite of being fraught with unending engagements in office, he kept me motivating
to try best at all times. I am also thankful to Mr. Srinivas who helped me in creating the basic
knowledge base required for the project and motivating me throughout my SIP duration.
I would like to take this opportunity to thank Prof. Viswanathan Iyer - Faculty Guide, IBS
Hyderabad, for being a very supportive and helpful. His constant motivation and willingness to
help at any point of time have been key factors in the successful completion of the report.
At this point of time, I would also like to thank all members at Edelweiss Financial Advisors,
friends and my family who provided me valuable insights and have been very supportive and
friendly in providing an environment for learning.
Lastly, I would like to thank IBS, Hyderabad and Edelweiss Financial Advisors, Hyderabad for
providing me an opportunity to gain hands-on experience by working in a corporate
environment.
3
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 4/52
TABLE OF CONTENTS
PAGE NO.
AUTHORIZATION 2
ACKNOWLEDGEMENT 3
EXECUTIVE SUMMARY 6
INTRODUCTION 7
MAIN TEXT 27
OBJECTIVE 27
METHODOLOGY 28
ANALYSIS 29
LIMITATIONS OF THE STUDY 31
CONCLUSION 32
FINDINGS 34
ANNEXTURE 35
REFERENCES 56
4
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 5/52
LIST OF ILLUSTRATIONS
PAGE NO.
CORRELATION 35
WEEK1 36
WEEK2 36
WEEK3 36
WEEK4 37
WEEK5 37
MONTH1 37
MONTH2 38
MONTH3 38
HALFYEAR1 38
HALF YEAR2 39
TOTAL 39
HISTORICAL VOLATILITY VS VIX 40
EXECUTIVE SUMMARY
5
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 6/52
This project has been carried out to understand the computation of CBOE’S Volatility Index
(VIX). This research was carried out to understand the application of VIX and analyse how VIX
can be used in trading in the financial markets.
The India VIX is computed on similar lines with CBOE VIX with certain changes. The various
factors which affect the India VIX has been explained with proper examples which help in
understanding the application of VIX.
The various trading strategies which use VIX has been explained and their use has been
statistically tested to show their use in trading in the equity markets. The VIX 5% Rule and the
negative correlation between the India VIX and Nifty has been explained. The research can be
of great help to the investors and traders to trade more efficiently and earn better profits.
The VIX 5% rule is tested using the data of India VIX and Nifty using M S Excel and the
correlation between the India VIX and Nifty has been calculated by simple linear correlation.
The analysis of the data shows that the strategy works on majority of trading sessions and the
buy and sell signals generated were found to be correct with big moves. The correlation
calculated was calculated for various durations were negative for all durations. This negative
correlation can be used for hedging portfolios.
With the help of this project investors will be benefited with detailed information about the
derivative market in India and new developments in the Indian derivative market. This will
prepare them for future developments in Indian markets and gain from it. VIX and derivatives
based on it are gaining popularity in developed markets of the world and will soon be launchedin India so prior knowledge and information on how to use these can give investors a better
chance to gain from it.
INTRODUCTION
6
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 7/52
INDUSTRY BACKGROUND
Brokerage
Brokerage firms are the business entities that deal with stock trading. India, having an increasing
capital market and a growing number of investors, has a number of brokerage firms. In Indian
retail brokerage industry, the brokerage firms primarily work as agents for buying and selling of
securities like shares, stocks and other financial instruments and earn commission for each of
the transactions.
The industry is one of the most important provider classes in the wealth management space in
the country—vertically cutting across all customer segments and horizontally cutting across allasset classes.
Indian retail brokerage market is going through a wonderful phase with high growth rate. The
total trading volume of the Indian brokerage companies stood at US$ 1239.1 billion in the year
2004, which increased to US$ 1492.1 billion in 2005. It is further expected to reach US$ 6535.7
billion by the year 2015.
Brokerage houses in India are trying to adopt a multi-modal distribution model to increase
market share. Firms are trying to graduate up the value chain to increase profitability and create
a new platform for positioning themselves as wealth managers. Brokerages are increasinglytrying to strike a balance between addressing customer segments profitably and grabbing market
share by repositioning themselves on a suitable wealth management platform.
Financial Advisor
A professional who helps individuals manage their finances by providing advice on money
issues such as investments, insurance, mortgages, college savings, estate planning, taxes and
retirement, depending on what the client requests. Some financial advisers are paid a flat fee for
their advice, while others earn commissions from the investments they sell to their clients. Fee-
only arrangements are widely regarded to be better for the client.
COMPANY BACKGROUND
7
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 8/52
Anagram Capital Ltd.(Anagram) is amongst the leading retail broking houses in India. It is
engaged in offering comprehensive personal finance solutions since 1994. Anagram offers a
wide range of services for the discerning equity investor, in addition to online account access
and real time trading. The company is a part of the Edelweiss Group. Edelweiss is one of theleading integrated financial services companies in India.
Market and Network
Anagram has membership in all the leading stock and commodities exchanges in the country.
The firm is a member in NSE, BSE, NCDEX and MCX. It is a depository participant with
NSDL. Anagram has its roots in Western India and has established nationwide presence with
169 branches, 1,360 sub-brokers, 2,556 terminals and a professional team of 2,000 plus
employees spread across major metros and states in the country. It also provides trading in
futures and options through its online portal www.anagram.co.in
Areas of Expertise
Anagram offers real time trading opportunities on the BSE as well as the NSE. It also offers
depository and online services to clients for account accessing and information through its
online portal catering to the needs of mobile trader as well as the net savvy investor. Anagram
offers state-of –the–art online trading through its website (www.anagram.co.in). Regular
updates during trading hours, and access to information, analysis and research, and a range of
monitoring tools is available. The company has steadily building up a comprehensive portfolio
of products and services apart from conventional broking. High speed anywhere trading through
the net, online depository services, commodities trading and retail debt products are increasingly
areas of special emphasis for the company.
Research
Anagram is a research driven organization. Daily Call is its morning newsletter that takes a
trading call on the market and gives a ringside view of the overnight national and international
events. Customers get real time feeds on news, comments and recommendations through instant
messaging that are of utmost essence to the serious trader. The Weekly Watch delivered to all
the clients every Saturday evening is the most comprehensive reports of its kind. The report
summons developments over the past week, major economic talking points, summary on
derivatives markets, technical outlook and trading ideas for the forthcoming week and
fundamental investments with an exhaustive research report for a medium to long term horizon.
On the commodities side, it releases daily and weekly reports providing outlook on international
agri-commodities.
Insurance
Life Insurance Products are absolutely necessary like providing Shelter for your family or
education to your children. Life Insurance is the only financial instruments which take care of
8
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 9/52
the standard of living and financial stability to the family in case of eventuality of disability or
death. The Main qualities of Insurance are Safety, Protection and Return. Life Insurance is the
only product which covers you during all cycles of your life and beyond. It is important to plan
while you are earning, to safeguard yourself and your family against all unexpected odds.Our
Services available at ZERO Cost through our Pan India Network branches
Mutual Funds
Anagram provides a host of services for customers investing in mutual funds. It offers wide
range of services like, rankings of different mutual fund schemes, list of new schemes issued in
the market, interviews with fund managers, Insta-Nav a quick search based application that
enables customers to get the related information about the desired scheme, Primer – a brief
description about mutual funds, RBI procedural guidelines and a Risk Profiler – which helps the
customers in ascertaining one’s own profile, thus minimizing risk.
Advisory ServicesApart from broking business, Anagram is also engaged in offering advisory services of
investments into mutual funds, primary market, life insurance and other small saving products.
The distribution services add up to their broking business and are serviced by experts at each
location. The business is supported by an efficient research and back office team. Anagram’s set
of diligent advisors helps its customers plan and get more out of one’s money. The schemes
include, fixed income, bank fixed deposits, company fixed deposits, small savings schemes, tax
saving schemes and NRI deposits. Anagram also provides tax planning services – where a list of
tax saving schemes and a forum for Q&A where the queries are answered by the tax advisors;
and an NRI advisory body, where it provides information for NRIs in helping them makes
judicious investment decisions.
Loan Advisory
Anagram also provides advisory services on the loan schemes of certain banks to its customers.
The schemes include, home loans, adhoc loans, professional loans, educational loans, consumer
loans and auto loans. Its advisory services are classified into four categories namely; Primers –
giving an overview about all schemes that are available, Calculators – where it helps the
customers with quick calculators, Jargon Buster – a translator and Digital Advisors – which help
in making decisions easy. It has entered into partnership with many leading banks in providing
this facility.
Performance
The company registered strong growth during the first 10 months of 2007. The company added
26,460 domestic customer accounts in 2007 as compared to 25,295 in 2006. Number of
terminals, sub brokers and employees almost doubled during this period.
Growth Areas
Anagram has diversified its business to other areas such as portfolio management services and is
9
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 10/52
looking forward at opening overseas branches. It plans to introduce company fixed deposits and
merchant banking to its current offerings. It is also aiming at increasing their institutional client
base, acquiring new business/brokerage firms and also entering into joint venture operations in
the near future.
SECURITIES MARKET IN INDIA–AN OVERVIEW
The securities markets in India have witnessed several policy initiatives, which has refined the
market micro-structure, modernised operations and broadened investment choices for the
investors. The irregularities in the securities transactions in the last quarter of 2000-01, hastened
the introduction and implementation of several reforms. While a Joint Parliamentary Committee
was constituted to go into the irregularities and manipulations in all their ramifications in all
transactions relating to securities, decisions were taken to complete the process of demutualisation and corporatisation of stock exchanges to separate ownership, management and
trading rights on stock exchanges and to effect legislative changes for investor protection, and to
enhance the effectiveness of SEBI as the capital market regulator. Rolling settlement on T+5
basis was introduced in respect of most active 251 securities from July 2, 2001 and in respect of
balance securities from 31s t December 2001. Rolling settlement on T+3 basis commenced for
all listed securities from April 1, 2002 and subsequently on T+2 basis from April 1, 2003. All
deferral products such as carry forward were banned from July 2, 2002.
At the end of March 2008, there were 1,381 companies listed at NSE and 1,236 companies were
available for trading. The Capital Market segment of NSE reported a trading volume of
Rs.35,51,038 crore during 2007-08 and at the end of March 2008, the NSE Market
Capitalisation was Rs.48,58,122 crore.
The derivatives trading on the NSE commenced with the S&P CNX Nifty Index Futures on June
12, 2000. The trading in index options commenced on June 4, 2001 and trading in options on
individual securities commenced on July 2, 2001. Single stock futures were launched on
November 9, 2001. Thereafter, a wide range of products have been introduced in the derivatives
segment on the NSE. The Index futures and options are available on Indices - S&P CNX
Nifty, CNX Nifty Junior, CNX 100, CNX IT, Bank Nifty and Nifty Midcap 50.Single stock futures are available on more than 250 stocks. The mini derivative contracts (futures and
options) on S&P CNX Nifty were introduced for trading on January 1, 2008 while the Long
term Options Contracts on S&P CNX Nifty were launched on March 3, 2008.
Due to rapid changes in volatility in the securities market from time to time, there was a need
felt for a measure of market volatility in the form of an index that would help the market
10
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 11/52
participants. NSE launched the India VIX, a volatility index based on the S&P CNX Nifty Index
Option prices. Volatility Index is a measure of market’s expectation of volatility over the near
term.
Other than the introduction of new products in the Indian stock markets, the Indian Stock
Market Regulator, Securities & Exchange Board of India (SEBI) allowed the direct marketaccess (DMA) facility to investors in India on April 3, 2008. To begin with, DMA was extended
to the institutional investors. In addition to the DMA facility, SEBI also decided to permit all
classes of
investors to short sell and the facility for securities lending and borrowing scheme was
operationalised on April 21, 2008.
The Debt markets in India have also witnessed a series of reforms, beginning in the year 2001-
02 which was quite eventful for debt markets in India, with implementation of several important
decisions like setting up of a clearing corporation for government securities, a negotiateddealing system to facilitate transparent electronic bidding in auctions and secondary market
transactions on a real time basis and dematerialisation of debt instruments. Further, there was
adoption of modified Delivery-versus-Payment mode of settlement (DvP III in March 2004).
The settlement system for transaction in government securities was standardized to T+1 cycle
on May 11, 2005. To provide banks and other institutions with a more advanced and more
efficient
trading platform, an anonymous order matching trading platform (NDS-OM) was introduced in
August 2005. Short sale was permitted in G-secs in 2006 to provide an opportunity to market
participants to manage their interest rate risk more effectively and to improve liquidity in the
market. ‘When issued’ (WI) trading in Central Government Securities was introduced in 2006.
As a result of the gradual reform process undertaken over the years, the Indian G-Sec market
has become increasingly broad-based and characterized by an efficient auction process, an
active secondary market, electronic trading and settlement technology that ensures safe
settlement with Straight through Processing (STP).
We have taken the stock market developments since 1990. These developments in the securities
market, which support corporate initiatives, finance the exploitation of new ideas and facilitate
management of financial risks, hold out necessary impetus for growth,development and strength
of the emerging market economy of India.
INTRODUCTION TO DERIVATIVES
11
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 12/52
The emergence of the market for derivative products, most notably forwards, futures and
options, can be traced back to the willingness of risk-averse economic agents to guard
themselves against uncertainties arising out of fluctuations in asset prices. By their very nature,
the financial markets are marked by a very high degree of volatility. Through the use of
derivative products, it is possible to partially or fully transfer price risks by locking-in asset prices. As instruments of risk management, these generally do not influence the fluctuations in
the underlying asset prices. However, by locking in asset prices, derivative products minimize
the impact of fluctuations in asset prices on the profitability and cash flow situation of risk-
averse investors.
Derivative products initially emerged as hedging devices against fluctuations in commodity
prices, and commodity-linked derivatives remained the sole form of such products for almost
three hundred years. Financial derivatives came into spotlight in the post-1970 period due to
growing instability in the financial markets. However, since their emergence, these products
have become very popular and by 1990s, they accounted for about two-thirds of totaltransactions in derivative products. In recent years, the market for financial derivatives has
grown tremendously in terms of variety of instruments available, their complexity and also
turnover. In the class of equity derivatives the world over, futures and options on stock indices
have gained more popularity than on individual stocks, especially among institutional investors,
who are major users of index-linked derivatives. Even small investors find these useful due to
high correlation of the popular indexes with various portfolios and ease of use.
DERIVATIVES DEFINED
Derivative is a product whose value is derived from the value of one or more basic variables,
called bases (underlying asset, index, or reference rate), in a contractual manner. The underlying
asset can be equity, forex, commodity or any other asset. For example, wheat farmers may wish
to sell their harvest at a future date to eliminate the risk of a change in prices by that date. Such a
transaction is an example of a derivative. The price of this derivative is drive by the spot price of
wheat which is the "underlying".
In the Indian context the Securities Contracts (Regulation) Act, 1956 (SC(R)A) defines
"derivative" to include-
1. A security derived from a debt instrument, share, loan whether secured or unsecured, risk
instrument or contract for differences or any other form of security.
2. A contract which derives its value from the prices, or index of prices, of underlying securities.
Derivatives are securities under the SC(R)A and hence the trading of derivatives is governed by
the regulatory framework under the SC(R)A.
12
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 13/52
PARTICIPANTS IN THE DERIVATIVES MARKETS
The following three broad categories of participants - hedgers, speculators, and arbitrageurstrade in the derivatives market. Hedgers face risk associated with the price of an asset. They use
futures or options markets to reduce or eliminate this risk. Speculators wish to bet on future
movements in the price of an asset. Futures and options contracts can give them an extra
leverage; that is, they can increase both the potential gains and potential losses in a speculative
venture. Arbitrageurs are in business to take advantage of a discrepancy between prices in two
different markets. If, for example, they see the futures price of an asset getting out of line with
the cash price, they will take offsetting positions in the two markets to lock in a profit.
TYPES OF DERIVATIVES
The most commonly used derivatives contracts are forwards, futures and options which we shall
discuss in detail later. Here we take a brief look at various derivatives contracts that have come
to be used.
Forwards: A forward contract is a customised contract between two entities, where settlement
takes place on a specific date in the future at today’s preagreed price.
Futures: A futures contract is an agreement between two parties to buy or sell an asset at a
certain time in the future at a certain price. Futures contracts are special types of forwardcontracts in the sense that the former are standardised exchange-traded contracts.
Options: Options are of two types – calls and puts. Calls give the buyer the right but not the
obligation to buy a given quantity of the underlying asset, at a given price on or before a given
future date. Puts give the buyer the right, but not the obligation to sell a given quantity of the
underlying asset at a given price on or before a given date.
Warrants: Options generally have lives of upto one year, the majority of options traded on
options exchanges having maximum maturity of nine months. Longer-dated options are called
warrants and are generally traded over-the-counter.
LEAPS: The acronym LEAPS means Long Term Equity Anticipation Securities. These are
options having a maturity of upto three years.
Baskets: Basket options are options on portfolios of underlying assets. The underlying asset is
usually a moving average or a basket of assets. Equity index options are a form of basket
options.
13
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 14/52
Swaps: Swaps are private agreements between two parties to exchange cash flows in the future
according to a prearranged formula. They can be regarded as portfolios of forward contracts.
The two commonly used swaps are:
Interest rate swaps: These entail swapping only the interest related cash flows between the
parties in the same currency
Currency Swaps: These entail swapping both principal and interest between the parties, with
the cash flows in one direction being in a different currency than those in the opposite direction.
Swaptions: Swaptions are options to buy or sell a swap that will become operative at the expiry
of the options. Thus, swaptions is an option on a forward swap. Rather than have calls and puts,
the swaptions market has receiver swaptions and payer swaptions A receiver swaption is an
option to receive fixed and pay floating. A payer swaption is an option to pay fixed and receivefloating.
SOME OF THE DERIVATIVES IN DETAIL:
Forward Contract
A forward contract is an agreement to buy or sell an asset on a specified date for a specified
price. One of the parties to the contract assumes a long position and agrees to buy the underlying
asset on a certain specified future date for a certain specified price. The other party assumes a
short position and agrees to sell the asset on the same date for the same price. Other contract
details like delivery date, price and quantity are negotiated bilaterally by the parties to the
contract. The forward contracts are normally traded outside the exchanges.
The salient features of forward contracts are:
They are bilateral contracts and hence exposed to counter–party risk.
Each contract is custom designed, and hence is unique in terms of contract size, expiration
date and the asset type and quality.
The contract price is generally not available in public domain.
On the expiration date, the contract has to be settled by delivery of the asset.
14
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 15/52
If the party wishes to reverse the contract, it has to compulsorily go to the same counterparty,
which often results in high prices being charged.
Forward markets world-wide are afflicted by several problems:
- Lack of centralisation of trading,
- Illiquidity, and
- Counterparty risk
In the first two of these, the basic problem is that of too much flexibility and generality. The
forward market is like a real estate market in that any two consenting adults can form contractsagainst each other. This often makes them design terms of the deal which are very convenient in
that specific situation, but makes the contracts non-tradable. Counterparty risk arises from the
possibility of default by any one party to the transaction. When one of the two sides to the
transaction declares bankruptcy, the other suffers. Even when forward markets trade
standardised contracts, and hence avoid the problem of illiquidity, still the counterparty risk
remains a very serious issue.
Futures
Futures markets were designed to solve the problems that exist in forward markets. A futures
contract is an agreement between two parties to buy or sell an asset at a certain time in the future
at a certain price. But unlike forward contracts, the futures contracts are standardised and
exchange traded. To facilitate liquidity in the futures contracts, the exchange specifies certain
standard features of the contract. It is a standardised contract with standard underlying
instrument, a standard quantity and quality of the underlying instrument that can be delivered,
(or which can be used for reference purposes in settlement) and a standard timing of such
settlement. A futures contract may be offset prior to maturity by entering into an equal and
opposite transaction. More than 99% of futures transactions are offset this way.
The standardised items in a futures contract are:
Quantity of the underlying
Quality of the underlying
15
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 16/52
The date and the month of delivery
The units of price quotation and minimum price change
Location of settlement
Options
Options are fundamentally different from forward and futures contracts. An option gives the
holder of the option the right to do something. The holder does not have to exercise this right. In
contrast, in a forward or futures contract, the two parties have committed themselves to doing
something. Whereas it costs nothing (except margin requirements) to enter into a futures
contract, the purchase of an option requires an upfront payment.
There are two basic types of options, call options and put options.
Call option: A call option gives the holder the right but not the obligation to buy an asset by a
certain date for a certain price.
Put option: A put option gives the holder the right but not the obligation to sell an asset by a
certain date for a certain price.
American options: American options are options that can be exercised at any time upto the
expiration date. Most exchange-traded options are American.
European options: European options are options that can be exercised only on the expiration
date itself. European options are easier to analyse than American options, and properties of an
American option are frequently deduced from those of its European counterpart.
DERIVATIVES MARKET IN INDIA
The first step towards introduction of derivatives trading in India was the promulgation of the
Securities Laws (Amendment) Ordinance, 1995, which withdrew the prohibition on options in
securities. The market for derivatives, however, did not take off, as there was no regulatory
16
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 17/52
framework to govern trading of derivatives. SEBI set up a 24-member committee under the
Chairmanship of Dr. L. C. Gupta on November 18, 1996 to develop appropriate regulatory
framework for derivatives trading in India. The committee submitted its report on March 17,
1998 prescribing necessary preconditions for introduction of derivatives trading in India. The
committee recommended that derivatives should be declared as ‘securities’ so that regulatoryframework applicable to trading of ‘securities’ could also govern trading of securities. SEBI also
set up a group in June 1998 under the chairmanship of Prof. J. R. Varma, to recommend
measures for risk containment in derivatives market in India. The report, which was submitted
in October 1998, worked out the operational details of margining system, methodology for
charging initial margins, broker net worth, deposit requirement and real-time monitoring
requirements.
The SCRA was amended in December 1999 to include derivatives within the ambit of
‘securities’ and the regulatory framework was developed for governing derivatives trading. The
act also made it clear that derivatives shall be legal and valid only if such contracts are traded ona recognised stock exchange, thus precluding OTC derivatives. The government also rescinded
in March 2000, the three-decade old notification, which prohibited forward trading in securities.
Derivatives trading commenced in India in June 2000 after SEBI granted the final approval to
this effect in May 2000. SEBI permitted the derivatives segments of two stock exchanges NSE
and BSE, and their clearing house corporation to commence trading and settlement in approved
derivatives contracts. To begin with, SEBI approved trading in index futures contracts based on
S&P CNX Nifty and BSE-30 (Sensex) index. This was followed by approval for trading in
options which commenced in June 2001 and the trading in options on individual securities
commenced in July 2001. Futures contracts on individual stocks were launched in November
2001. Futures and Options contracts on individual securities are available on more than 200
securities. Trading and settlement in derivative contracts is done in accordance with the rules,
byelaws, and regulations of the respective exchanges and their clearing house/ corporation duly
approved by SEBI and notified in the official gazette.
NSE's DERIVATIVES MARKET
The derivatives trading on the NSE commenced with S&P CNX Nifty Index futures on June 12,
2000. The trading in index options commenced on June 4, 2001 and trading in options on
individual securities commenced on July 2, 2001. Single stock futures were launched on
November 9, 2001. Today, both in terms of volume and turnover, NSE is the largest derivatives
exchange in India. Currently, the derivatives contracts have a maximum of 3-month expiration
17
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 18/52
cycles. Three contracts are available for trading, with 1 month, 2 months and 3 months expiry. A
new contract is introduced on the next trading day following the expiry of the near month
contract.
VOLATILITY IN STOCK MARKET
The relative rate at which the price of a s ecurity moves up and down. Volatility is found by calculating
the annualized standard deviation of daily change in price. If the price of a stock moves up and down
rapidly over short time periods, it has high volatility. If the price almost never changes, it has low
volatility.
Investors care about volatility for five reasons.
1) The wider the swings in an investment's price the harder emotionally it is to not worry.
2) When certain cash flows from selling a security are needed at a specific future date, higher volatility means a greater chance of a shortfall.
3) Higher volatility of returns while saving for retirement results in a wider distribution of
possible final portfolio values.
4) Higher volatility of return when retired gives withdrawals a larger permanent impact on the
portfolio's value.
5) Price volatility presents opportunities to buy assets cheaply and sell when overpriced.
In today's markets, it is also possible to trade volatility directly, through the use of derivative
securities such as options and variance swaps
HISTORICAL VOLATILITY
The realized volatility of a financial instrument over a given time period. Generally, this
measure is calculated by determining the average deviation from the average price of a financial
instrument in the given time period. Standard deviation is the most common but not the only
way to calculate historical volatility.
This measure is frequently compared with implied volatility to determine if options prices areover- or undervalued. Historical volatility is also used in all types of risk valuations. Stocks with
a high historical volatility usually require a higher risk tolerance.
Historical Volatility is a measure of price fluctuation over time. Historical volatility uses
historical (daily, weekly, monthly, quarterly, and yearly) price data to empirically measure the
volatility of a market or instrument in the past. The value rendered by a historical volatility
study is the standard deviation of bar-to-bar price differences.
18
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 19/52
Formula:
Standard Deviation, or Historical Volatility:
Where:
s = standard deviation, or historical volatility
n = number of occurrences (bars)
m = mean
xi = price changes
And:
Mean:
Where:
m = mean
n = number of occurrences
xi = price changes
And:
xi can equal percent of price change:
Or:
19
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 20/52
xi can equal natural logarithmic price change:
THE CBOE VOLATILITY INDEX – VIX
The CBOE Volatility Index(VIX) is a key measure of market expectations of near-term
volatility conveyed by S&P 500 stock index option prices. Since its introduction in 1993, VIX
has been considered by many to be the world's premier barometer of investor sentiment and
market volatility.
In 1993, the Chicago Board Options Exchang (CBOE) introduced the CBOE Volatility
Index®, VIX, which was originally designed to measure the market’s expectation of 30-
day volatility implied by at-the-money S&P 100 Index (OEX) option prices. VIX soon
became the premier benchmark for U.S. stock market volatility. It is regularly featured in
the Wall Street Journal, Barron’s and other leading financial publications, as well as
business news shows on CNBC, Bloomberg TV and CNN/Money, where VIX is often
referred to as the “fear index.”
Ten years later in 2003, CBOE together with Goldman Sachs, updated the VIX to reflect a new
way to measure expected volatility, one that continues to be widely used by financial theorists,
risk managers and volatility traders alike. The new VIX is based on the S&P 500 Index
(SPXSM), the core index for U.S. equities, and estimates expected volatility by averaging the
weighted prices of SPX puts and calls over a wide range of strike prices. By supplying a script
for replicating volatility exposure with a portfolio of SPX options, this new methodology
transformed VIX from an abstract concept into a practical standard for trading and hedging
volatility.
Futures on VIX, CBOE's trademark Market Volatility Index, provide a pure play on implied
volatility independent of the direction and level of stock prices. VIX futures may also provide an
effective way to hedge equity returns, to diversify portfolios, and to spread implied againstrealized volatility.
Timeline of some key events in the history of the VIX Index:
20
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 21/52
1993 The VIX Index is introduced in a paper by Professor Robert E. Whaley of Duke
University.
2003 Methodology for VIX is revised.
2004 On March 26, 2004, the first-ever trading in futures on the VIX Index began on CBOE
Futures Exchange (CFE).
2006 VIX options launched in February 2006.
2008 VIX Binary Options introduced.
2009 Mini-VIX futures introduced.
2010 Weekly options on VIX futures introduced.
INTRODUCTION OF VIX IN INDIA
Volatility Index is a measure of market’s expectation of volatility over the near term. Volatility
is often described as the “rate and magnitude of changes in prices” and in finance often referred
to as risk. Volatility Index is a measure, of the amount by which an underlying Index is expected
to fluctuate, in the near term, (calculated as annualised volatility, denoted in percentage e.g.
20%) based on the order book of the underlying index options.
India VIX is a volatility index based on the NIFTY Index Option prices. From the best bid-ask
prices of NIFTY Options contracts, a volatility figure (%) is calculated which indicates the
expected market volatility over the next 30 calendar days. India VIX uses the computationmethodology of CBOE, with suitable amendments to adapt to the NIFTY options order book
using cubic splines, etc.
India VIX is a volatility index based on the index option prices of NIFTY. India VIX is
computed using the best bid and ask quotes of the out-of-the-money near and mid-month
NIFTY option contracts which are traded on the F&O segment of NSE. India VIX indicates the
investor’s perception of the market’s volatility in the near term. The index depicts the expected
market volatility over the next 30 calendar days. i.e. higher the India VIX values, higher the
expected volatility and vice-versa.
India VIX computation methodology
India VIX uses the computation methodology of CBOE, with suitable amendments to adapt to
the NIFTY options order book using cubic splines, etc
21
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 22/52
The factors considered in the computation of India VIX are mentioned below:
1) Time to expiry: The time to expiry is computed in minutes instead of days in order to arrive
at a level of precision expected by professional traders.
2) Interest Rate: The relevant tenure NSE MIBOR rate (i.e 30 days or 90 days) is being
considered as risk-free interest rate for the respective expiry months of the NIFTY option
contracts
3) The forward index level: India VIX is computed using out-of-the-money option contracts.
Out-of-the-money option contracts are identified using forward index level. The forward index
level helps in determining the at-the-money (ATM) strike which in turn helps in selecting the
option contracts which shall be used for computing India VIX. The forward index
level is taken as the latest available price of NIFTY future contract for the respective expiry
month.
4) Bid-Ask Quotes
The strike price of NIFTY option contract available just below the forward index level is taken
as the ATM strike. NIFTY option Call contracts with strike price above the ATM strike and
NIFTY option Put contracts with strike price below the ATM strike are identified as out-of-the-
money options and best bid and ask quotes of such option contracts are used for computation of
India VIX. In respect of strikes for which appropriate quotes are not available, values are
arrived through interpolation using a statistical method namely “Natural Cubic Spline” After
identification of the quotes, the variance (volatility squared) is computed separately for near and
mid month expiry. The variance is computed by providing weightages to each of the NIFTY
option contracts identified for the computation, as per the CBOE method. The weightage of a
single option contract is directly proportional to the average of best bid-ask quotes of the option
contract and inversely proportional to the option contract’s strike price
Computation of India VIX
The variance for the near and mid month expiry computed separately are interpolated to get a
single variance value with a constant maturity of 30 days to expiration. The squareroot of the
computed variance value is multiplied by 100 to arrive at the India VIX value.
22
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 23/52
Future of India Vix Futures
NSE is soon going to start India Vix Futures trading which is going to be the first instrument
based on the volatility index for India. It’s a very good product and very relevant for the
current stock market conditions and also very necessary for the indian markets to have a product based on the market volatility if we want to make India, a developed and matured
market.
The contract specifications like contract lot size, tick values, margin requirements are not yet out
but the real question is whether it is going to attract enough liquidity or not? Right now, there
are only two exchanges which have successfully launched instruments on the volatility index in
the world, VIX by CBOE and VSTOXX by Eurex. Other exchanges tried but failed to make it
popular among the traders.
• Germany’s stock exchange, DTB launched VOLAX futures on DAX in Jan 1998 but
has to withdraw the product in the same year in Dec 1998. We may say markets atthat time may not be ready to accept this product.
• CBOE successfully launched VIX Futures in March 2004.
• CBOE launched DJIA volatility Futures in Apr 2005, continued it for 4 years but has
to delist it in Aug 2009.
• Eurex lists futures on VDAX, VSMI, and VSTOXX in Sep 2005 but has to delist
each one of them in Jul 2009. VSTOXX however was relaunched as mini again.
• CBOE sucessfully lists VIX options.
• CBOE lists Nasdaq and Russell 2000 volatility futures in Jul 2007 but failed and
delist the contracts in Feb 2009 and Feb 2010 respectively.
• Eurex lists options on VSTOXX in Mar 2010.
Looking at the history of volatility index products in the world arena, there are more failures
then successes when it comes to instruments on volatility index and hence there is a huge
question mark on whether IndiaVix is going to be successful or not. In India, high market
volatility and absence of other developed products to hedge volatility risks may make IndiaVix a
success. Some other exchanges are also coming up with volatility futures like VKOSPI futures,Japanese VIX futures.
VIX BASED DERIVATIVES
CBOE Volatility Index (VIX) Futures
CONTRACT NAME: CBOE Volatility Index (VIX) Futures
23
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 24/52
LISTING DATE: March 26, 2004
DESCRIPTION: The CBOE Volatility Index is based on real-time prices of options on the
S&P 500 Index, listed on the Chicago Board Options Exchange (Symbol: SPX), and is designed
to reflect investors' consensus view of future (30-day) expected stock market volatility.
CONTRACT SIZE: $1000 times the VIX
CONTRACT MONTHS: The Exchange may list for trading up to nine near-term serial months
and five months on the February quarterly cycle for the VIX futures contract.
FINAL SETTLEMENT VALUE: The final settlement value for VIX futures shall be a Special
Opening Quotation (SOQ) of VIX calculated from the sequence of opening prices of the options
used to calculate the index on the settlement date. The opening price for any series in which
there is no trade shall be the average of that option's bid price and ask price as determined at the
opening of trading. The final settlement value will be rounded to the nearest $0.01. If the finalsettlement value is not available or the normal settlement procedure cannot be utilized due to a
trading disruption or other unusual circumstance, the final settlement value will be determined
in accordance with the rules and bylaws of The Options Clearing Corporation.
DELIVERY: Settlement of VIX futures contracts will result in the delivery of a cash settlement
amount on the business day immediately following the Final Settlement Date. The cash
settlement amount on the Final Settlement Date shall be the final mark to market amount against
the final settlement value of the VIX futures multiplied by $1000.00.
CBOE VOLATILITY INDEX(VIX) OPTIONS
Underlying: The CBOE Volatility Index - more commonly referred to as "VIX" - is an up-to-the-minute market estimate of expected volatility that is calculated by using real-time S&P500® Index (SPX) option bid/ask quotes. VIX uses nearby and second nearby options with atleast 8 days left to expiration and then weights them to yield a constant, 30-day measure of theexpected volatility of the S&P 500 Index.
Multiplier:$100.
Strike Price Intervals: Minimum strike price intervals of not less than $1.00 are permissible,
subject to certain conditions. (See CBOE Rule 24.9, Interpretations and Policies .01 for more
complete information) Otherwise, strike price intervals shall not be less than $2.50.
Strike (Exercise) Prices: In-, at- and out-of-the-money strike prices are initially listed. New
strikes can be added as the index moves up or down.
24
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 25/52
Premium Quotation: Stated in points and fractions, one point equals $100. Minimum tick for
series trading below $3 is 0.05 ($5.00); above $3 is 0.10 ($10.00).
Expiration Date: The Wednesday that is thirty days prior to the third Friday of the calendar
month immediately following the expiring month.
Expiration Months: Up to six contract months may be listed, provided that the time to
expiration is no greater than 12 months.
Exercise Style: European - CBOE Volatility Index options generally may be exercised only on
the Expiration Date.
Last Trading Day: The Tuesday prior to the Expiration Date of each month.
Settlement of Option Exercise: The exercise-settlement value for VIX options (Ticker:
VRO) shall be a Special Opening Quotation (SOQ) of VIX calculated from the sequence of opening prices of the options used to calculate the index on the settlement date. The opening
price for any series in which there is no trade shall be the average of that option's bid price and
ask price as determined at the opening of trading. Exercise will result in delivery of cash on the
business day following expiration. The exercise-settlement amount is equal to the difference
between the exercise-settlement value and the exercise price of the option, multiplied by $100.
Position and Exercise Limits: No position and exercise limits are in effect. Each member
(other than a market-maker) or member organization that maintains an end of day position in
excess of 100,000 contracts in VIX for its proprietary account or for the account of a customer,
shall report certain information to the Department of Market Regulation. The member mustreport information as to whether such position is hedged and, if so, a description of the hedge
employed e.g. stock portfolio current market value, other stock index option positions, stock
index futures positions, options on stock index futures; and for customer accounts, provide the
account name, account number and tax ID or social security number. Thereafter, if the position
is maintained at or above the reporting threshold, a subsequent report is required on Monday
following expiration and when any change to the hedge results in the position being either
unhedged or only partially hedged. Reductions below these thresholds do not need to be
reported.
Margin Purchases of puts or calls with 9 months or less until expiration must be paid for in full.Writers of uncovered puts or calls must deposit / maintain 100% of the option proceeds* plus
15% of the aggregate contract value (current index level x $100) minus the amount by which the
option is out-of-the-money, if any, subject to a minimum for calls of option proceeds* plus 10%
of the aggregate contract value and a minimum for puts of option proceeds* plus 10% of the
aggregate exercise price amount. (*For calculating maintenance margin, use option current
market value instead of option proceeds.) Additional margin may be required pursuant to
Exchange Rule 12.10.
25
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 26/52
TRADING STRATEGIES
VIX 5% RULE
The proper way to use the VIX is to look at where it is today relative to its 10 day
simple moving average. The higher it is above the 10 day moving average, the greater the likelihood the market is oversold and a rally is near. On the opposite side, the lower
it is below the 10 day moving average, the more the market is overbought and likely to
move sideways-to-down in the near future.
This wisdom is further distilled into what TradingMarkets calls The Trading Markets 5%
Rul e: Do not buy stocks (or the market) anytime the VIX is 5% below its [10 day
simple] moving average.
The Same strategy has been applied to Nifty to find out the next day result after breaking either
above 5%(Buy Signal) or Below -5% and the strategy is to check the Next day behaiour of Nifty with repect to the Signal. And if VIX falls between -5% to 5% then the very next day it is
declared as a Dont Trade Day.
HISTORY
VIX 5% Rule: Be careful buying stocks anytime VIX is 5% below its MA. Since 1995, S&P
500 has lost money on a net basis 5 days following the times the VIX has been 5% below its 10-
day MA. Since 1995, whenever VIX has been 5% or more above its 10-day MA, the S&P 500
has achieved returns which are better than 2-1 compared to the average weekly returns of all
weeks
Edge lies in buying when VIX is at least 5% above its 10-day MA, and locking in gains (and
not buying) when VIX is 5% or more below its 10- day MA. When fear is great and VIX is
high, we want to be buying. When greed is prevalent and VIX is low, we want to be locking in
gains
and/or shorting the market.
According to experts……
The 5% rule (according to Larry Connors) basically says to be careful buying anytime the VIX
is 5% below its 10 dma because since 1995 the S&P 500 has lost money one a net basis 5 days
following the time the VIX has been 5% below its 10 dma. Conversely, whenever the VIX has
been 5% or more above its 10 dma, the S&P has achieved returns which are better than 2-1
compared to the average weekly returns or all weeks.
All this provides is an edge in timing entries, both long and short.
Personally, I take notice when the divergence is 5% or greater . If it goes more than 10% I get
26
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 27/52
fairly aggressive.
Of course, I must note that my trading style is short term reversion to the mean. At the other end
of the spectrum, there are those who favor momentum trading. Its all personal preference and
whatever works, go with it.
NEGATIVE CORRELATION OF VIX AND UNDERLYING INDEX.
The price of VIX often moves in the opposite direction of the underlying index (e.g, when stock
prices drop, implied volatility often rises). Investors might explore whether VIX options could
be a "catastrophe hedging" tool for stock portfolios.
The most notable feature of the VIX is its negative correlation with the price index. This
presents immense potential to use the volatility asset class as offered by the VIX as an effective
hedging instrument. The negative correlation of VIX with NIFTY makes it an excellent hedging
tool.
In a low interest rate environment, the need to add portfolio value is intensified for the average
investor. The introduction of a volatility asset class that is negatively correlated with equities
makes this job a bit easier. For over a decade, investors were intrigued by the VXO, which
became know in the press as the "fear gauge", for its ability to measure the amount of anxiety in
the equity market, but now there is an opportunity to trade volatility with VIX futures.
Volatility-based options and ETFs cannot be far away for the retail investor.
CONCLUSION
Modeling of market volatility is one of the most important issues of recent times. Accurate
modeling and forecast of volatility are of immense importance in managing the risk. The
current sub-prime crisis has further emphasized the importance of accurate modeling and
forecasting of volatility.
In the Indian context, the introduction of VIX has helped the traders gauge market sentiments
and many traders are already using VIX values for the trading calls. The introduction of
trading in VIX index will enable active management of risks that cannot be hedged. The
regulator will allow the trading in index as well when the market participants will become
comfortable with the index. We believe that the developed instruments like VIX willsignificantly contribute to the development of the emerging markets like India in the course of
time.
MAIN TEXT
OBJECTIVE
27
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 28/52
The main objective of my project report is to create an understanding in detail about the
derivatives ie. description about derivatives and derivative market in India. The derivative
market in India is developing and number of derivative trades is increasing every year and new
types of derivatives are being launched every year. An investor needs to keep himself updated
about all the latest devlopments in the market to earn greater returns from the market byinvesting in all possible avenues and take maximum benefit from the possessed market
knowledge. My report is trying to help the investors of Edelweiss Financial Advisors, the
company for which I was the intern to explain the upcoming asset classes and trends in the
financial markets.
I am analyzing Volatility Index (VIX) and trying to explain its computation and various factors
which are taken into consideration for its computation. VIX is relatively new concept which
computes the implied volatility. Implied Volatility helps in understanding the market sentiments
which helps to trade in the markets.
I am also explaining the various trading strategies which uses VIX and testing them so they can
be used by the investors or clients of the company to help them trade in a better way and earn
greater returns. I am explaining and testing various strategies such as VIX 5% Rule and negative
correlation between VIX and underlying index. I am also making a comparison between the
historical volatility and implied volatility which will help the traders in understanding the
difference between the two and make correct use of the available information.
METHODOLOGY
The study uses exploratory and descriptive approach. The techniques used will be qualitatative
as well as quantitative.
28
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 29/52
Qualitative Analysis would include: Detailed analysis of the derivative market in India.
In-depth knowledge of the INDIA VIX and its computation and other foctors which affect it and
its properties and future in India.
Quantitative analysis would include:
Testing of the VIX 5% Rule
Calculating the historical and comparing it with the implied volatility.
Calculating the correlation between INDIA VIX and NIFTY.
Data for all the calculations and other use.
Secondary data available on the internet and website of NSE will be used for literature
survey and also to gain an understanding of the philosophy of the derivative market in India .
ANALYSIS
VIX 5% RULE
The proper way to use the VIX is to look at where it is today relative to its 10 day simple
moving average. The higher it is above the 10 day moving average, the greater the likelihood the
29
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 30/52
market is oversold and a rally is near. On the opposite side, the lower it is below the 10 day
moving average, the more the market is overbought and likely to move sideways-to-down in the
near future.
The VIX 5% Rule was tested using the data of INDIA VIX and Nifty daily returns to check
whether the rule stands correct and check whether the trade signals generated by the rule gives
the correct result or not.
Samples are taken from 02-March-2009 to 28-Feb-2011(486 Trading Sessions) to test the
strategy and it found that out of 486 trading sessions VIX has given a buy/sell signal on 283
trading sessions. And out of 283 trading signals, 198 Signals are found accurate with big moves
in nifty counting from day high and 85 trading signals are Found inaccurate with Big moves.
On testing of the rule we could see that on 58% of the trading sessions it gave a trade signal and
70% of the signals were found to be correct with big moves.
From the trading signals its clear that the rule works fine on majority of times and this rule can
be followed by the investors to follow this rule and gain maximum benefits from it.
NEGATIVE CORRELATION BETWEEN VIX AND UNDERLYING INDEX.
The price of VIX often moves in the opposite direction of the underlying index (e.g, when stock
prices drop, implied volatility often rises). Investors might explore whether VIX options could
be a "catastrophe hedging" tool for stock portfolios.
The most notable feature of the VIX is its negative correlation with the price index. This
presents immense potential to use the volatility asset class as offered by the VIX as an effective
hedging instrument. The negative correlation of VIX with NIFTY makes it an excellent hedging
tool.
I have calculated the correlation between the India VIX and NIFTY for different durations and it
showed negative correlation for all durations and this can be used by traders to hedge their
portfolios by using vix based derivatives.
30
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 31/52
As we can see correlation is negative for all the durations.The correlation is significantly high in
all durations and is increasing as duration is increasing.This shows the inverse movement
relation between the VIX and the underlying price index.
COMPARISON OF HISTORICAL AND IMPLIED VOLATILITY.
Historical Volatility is a measure of price fluctuation over time. Historical volatility uses
historical (daily, weekly, monthly, quarterly, and yearly) price data to empirically measure the
volatility of a market or instrument in the past. The value rendered by a historical volatility
study is the standard deviation of bar-to-bar price differences.
VIX is a key measure of market expectations of near-term volatility conveyed by stock index
option prices.
This measure is frequently compared with implied volatility to determine if options prices are
over- or undervalued.
On comparison of historical volatility and vix we can see that whether the option prices are over
valued or under valued and can come to a conclusion whether to buy that security or not. This
DURATION CORRELATION
1 WEEK -0.4158
1 MONTH -0.724
6 MONTHS -0.3395
2-3-2009 TO 28-2-
2011
-0.834
31
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 32/52
will provide the critical information which can be used by them to conclude whether to trade the
stock or not.
LIMITATIONS OF THE STUDY
Paucity of time.
Data spread over limited time span i.e.2 ND March 2009-28 Feb 2011
Data used in the project is from secondary sources.
Few statistical tools will be used.
More research and more trading strategies could have been taken into consideration.
Response bias.
32
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 33/52
CONCLUSION
The project shows how different trading strategies using VIX can be used to earn greater
returns. From the study, it is evident that trading strategies such as VIX 5% Rule work can be
used by traders to trade in the market. The comparative analysis shows how well they generate
buy and sell signals which enable them so as to maximize their efficiency and performance.
Though correlation between vix and nifty we can understand that there is negative correlation
between them which actually means that when the market goes up the vix goes down and vice
versa happens. When the market declines the option prices and vix goes up and when market
goes up the option prices and vix goes down. When I compared the historical volatility and vixwe could conclude that when options are overvalued and when they are undervalued and when
can they be effectively traded.
From the analysis of vix and its computation of vix one can understand the various factors
which affect the computation of vix and how well they can be used in predicting the value and
future volatility which helps in trading.
33
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 34/52
FINDINGS
• The computation of vix uses various factors such as time to expiry, forward index level
and bid ask prices. From the understanding of these factors one can understand the
relationship between them and understand how to effectively use VIX.
• The VIX 5% Rule has been tested and it shows that it gives trade signal in 58% of the
trading sessions and 70% of them are correct with big moves.
• The correlation was calculated between vix and Nifty which gave negative correlation
for all the different durations from which we can conclude that it can be used for
hedging and trading purposes.
• When the historical volatility was calculated and compared with vix it was found that it
assits to know whether an option is over valued or under valued which can help
investors to trade in a better manner.
34
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 35/52
ANNEXTURE
CORRELATION
WEEKLY
Correlations ( WEEK 1)
VAR00002 VAR00003
VAR00002 Pearson Correlation1 -.830
Sig. (2-tailed).082
N5 5
VAR00003 Pearson Correlation-.830 1
Sig. (2-tailed).082
N5 5
Correlations ( WEEK 2)
VAR00002 VAR00003
VAR00002 Pearson
Correlation1 -.811
Sig. (2-tailed).096
N5 5
VAR00003 Pearson
Correlation-.811 1
Sig. (2-tailed).096
N 5 5
Correlations ( WEEK 3)
VAR00002 VAR00003
35
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 36/52
VAR00002 Pearson Correlation1 -.126
Sig. (2-tailed).840
N5 5
VAR00003 Pearson Correlation -.126 1
Sig. (2-tailed).840
N5 5
Correlations ( WEEK 4)
VAR00002 VAR00003VAR00002 Pearson Correlation1 -.338
Sig. (2-tailed).579
N5 5
VAR00003 Pearson Correlation.338 1
Sig. (2-tailed).579
N5 5
Correlations ( WEEK 4)
VAR00002 VAR00003
VAR00002 Pearson Correlation1 -.650
Sig. (2-tailed).235
N5 5
VAR00003 Pearson Correlation-.650 1
Sig. (2-tailed).235
N5 5
36
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 37/52
MONTHLY
Correlations (MONTH 1)
VAR00002 VAR00003VAR00002 Pearson Correlation1 .926(**)
Sig. (2-tailed).000
N21 21
VAR00003 Pearson Correlation.926(**) 1
Sig. (2-tailed).000
N21 21
** Correlation is significant at the 0.01 level (2-tailed).
Correlations (MONTH 2)
VAR00002 VAR00003
VAR00002 Pearson Correlation1 -.766(**)
Sig. (2-tailed).000
N20 20
VAR00003 Pearson Correlation-.766(**) 1
Sig. (2-tailed).000
N20 20
** Correlation is significant at the 0.01 level (2-tailed).
Correlations (MONTH 3)
37
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 38/52
VAR00002 VAR00003
VAR00002 Pearson Correlation1 -.480(*)
Sig. (2-tailed).032
N
20 20VAR00003 Pearson Correlation
-.480(*) 1
Sig. (2-tailed).032
N20 20
* Correlation is significant at the 0.05 level (2-tailed).
FOR EVERY HALF YEAR
Correlations (HALF YEARLY 1)
VAR00002 VAR00003
VAR00002 Pearson Correlation1 -.264(**)
Sig. (2-tailed).003
N123 123
VAR00003 Pearson Correlation-.264(**) 1
Sig. (2-tailed).003
N123 123
** Correlation is significant at the 0.01 level (2-tailed).
Correlations (HALF YEARLY 2)
VAR00006 VAR00005
VAR00006 Pearson Correlation1 -.415(**)
Sig. (2-tailed).000
N125 125
VAR00005 Pearson Correlation -.415(**) 1
38
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 39/52
Sig. (2-tailed).000
N125 125
** Correlation is significant at the 0.01 level (2-tailed).
TOTAL
Correlations (TOTAL 1)
VAR00002 VAR00003
VAR00002 Pearson Correlation1 -.834(**)
Sig. (2-tailed).000
N496 496
VAR00003 Pearson Correlation-.834(**) 1
Sig. (2-tailed).000
N496 496
** Correlation is significant at the 0.01 level (2-tailed).
HISTORICAL VOLITILITY VS VIX
39
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 40/5240
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 41/52
Date Close LOG volatility VIX
02-Mar-09 2674.6
-0.019709
907 43.1703-Mar-
09 2622.4
0.008656
748 43.89
04-Mar-09 2645.2
-0.026237
166 42.5205-Mar-
09 2576.70.016722
058 41.49
06-Mar-09 2620.15
-0.018100
739 38.1609-Mar-
09 2573.150.017069
732 40.87
12-Mar-09 2617.45
0.038155546 39.27
13-Mar-09 2719.25
0.021105122 35.56
16-Mar-09 2777.25
-0.007154
89 36.717-Mar-
09 2757.450.013418
427 38.4318-Mar-
09 2794.70.004444
967 38.15
19-Mar-09 2807.15
-3.5624E-05 37.74
20-Mar-09 2807.05
0.046241457 37
23-Mar-09 2939.9
-0.000408
26 38.5924-Mar-
09 2938.70.015414
661 38.0225-Mar-
09 2984.350.032277
882 37.4126-Mar-
09 3082.250.008528
699 37.23
27-Mar-09 3108.65
-0.042886
246 37.5830-Mar-
09 2978.150.014269
049 40.0931-Mar-
09 3020.950.012957
937 39.49
41
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 42/5242
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 43/5243
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 44/5244
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 45/5245
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 46/5246
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 47/5247
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 48/5248
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 49/5249
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 50/5250
8/3/2019 Pratik Tibrewala(Final Report)
http://slidepdf.com/reader/full/pratik-tibrewalafinal-report 51/5251
Recommended